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Do you who's going to screw who next week?

I
spent the majority of my Wednesday spreading my bearish positions
further around the European banks (the balance was catering to my beautiful, yet demanding 2 year old daughter). Let me give you a glimpse into some of the
reasons why. First a glance at the home page of Bloomberg.com yields...

SEC Clears U.S. Banks to Postpone Writedowns on Value of
Some Securities-
And so it begins, the obfuscation of
true market values of assets held on bank's books. They can't fool me though.
Now, preferred stock is to be called debt. When is debt to be called preferred stock.
When are we going to be notified if or when the assets a bank is holding and
paid for with leverage have dropped in value by 70%. Doesn't that make the bank
worth less. Maybe not, after all stock is really debt, right?

What does all this have to do with my buying of the European banks bear positions? Well, most are still much, much too optimistic about the financial sectors prospects here. The Monday rally was an opportunity to go shopping, and shopping I did, for price and value diverged even farther. While I won't divulge what I bought, I will share a little anecdotal research (more empirical research on this may be available to professional level subscribers next week). Before we go on, if you haven't read Interesting Lehman email, it is must reading to fully grasp the weight of the rest of this article.

The Lehman collapse has yet to be felt

The final number of enrolled bidders for
Lehman's debt auction, according to ISDA, was 358, among them the biggest
debt and derivatives dealers in the business. The final CDS settlement is 8.625%. of each dollar protected. Keep this
percentage in mind as I go through a list of companies that allegedly
have "de minimus exposure" or have had their positions "substantially
netted out". I use quotes because: a) these were the actual words
quoted by company reps, b)this is bullsh1t, the losses are real and
someone has to take them so I ask "How was this exposure netted out?",
and c) the recovery rate is close to zero, "de minimus" indeed. Keep in
mind the percentage quoted and realize that Lehman was the 10th largest
writer of CDS in the WORLD!

This smattering is not even scraping the
surface of what will take place next week. A rough estimation, this is
about 20% or less of the total creditors outstanding exposure on the hook.

Note and update:

We looked into exposure of Citibank and The Bank of New York
Mellon Corporation to Lehman’s debt and securities. Upon deeper analysis and
search, we observed that the exposure of these companies to Lehman is that of
administrative nature only and doesn’t represent any loss due to possibility of
non-payment of debt money by Lehman.

This was also recently clarified by Citibank in response to
Chapter 11 bankruptcy filing by Lehman disclosing exposure to the failed
investment firm.

Following was the clarification by Citibank:

Chapter 11 bankruptcy filing does not represent exposure to the
failed investment firm. "Citibank N.A. is listed in the Lehman Brothers
bankruptcy filing as an indenture trustee for bond debt of approximately $138
billion under Lehman Brothers Holdings Inc. Senior Notes," Citigroup said
in a statement. "Citi wishes to clarify that our role in this issue is
administrative in nature and does not represent exposure for Citi to Lehman.
Any assertions to the contrary are false."

Citigroup and Bank of New York Mellon are trustees to $138 billion
of Lehman Brothers' bonds, the biggest on the list of unsecured creditors,
according to a petition filed in New York bankruptcy court on Monday. Banks are
trying to calm employees and clients in the wake of Lehman's bankruptcy filing
Monday

We have, therefore, separately collated information on names and
exposure of entities in the US having exposure to Lehman. We are going to share
this list with you in a couple of hours. The list contains entity-wise details
of total exposure, estimated loss (in absolute amount and as % of equity). This
required a lot of manual efforts since a ready list was not available from any
source.

We shall be highlighting and sharing name of 5-6 companies having
potential exposure to Lehman, which have not witnessed significant fall in
their valuation in last 3 months. The guiding factor will be (among others)

·
Highest exposure as% of their respective equity

·
Share price above $15

·
Not significant fall in share price in last 3 months.

This report will be available to the professional subscribers when released.

The Bank of New York
Mellon Corporation, as indenture trustee under the Lehman Brothers Holdings
Inc. Subordinated Debt

Bond Debt

$12 billion

The Bank of New York
Mellon Corporation, as indenture trustee under the Lehman Brothers Holdings
Inc. Junior Subordinated Debt

Bond Debt

$5 billion

AOZORA

Bank Loan

$460 mn

Mizuho Corporate Bank,

Bank Loan

$289 mn

Citibank N.A. Hong Kong
Branch

Bank Loan

$275 mn

BNP Paribas

Bank Loan

$250 mn

Shinsei Bank Ltd.

Bank Loan

$231 mn

UFJ Bank Limited

Bank Loan

$185 mn

Sumitomo Mitsubishi
Banking Corp

Bank Loan

$177 mn

Bank Leumi (Israel's
largest bank)

WAMU Debentures

$27 mn

WAMU CDS

$23 mn

Here is a primer on the CDS risk that I am alluding to (from previous
posts). The rampant credit and counterparty risk is literally out of
control. I think there is hundreds of billions of dollars of worthless
paper sitting on derivative, loan and bond trading desks around the
globe. Even if I am wrong, most of these banks make decent shorts via
the macro argument anyway.

And back to the basic problem

The CDS insurance
contract created primarily to transfer credit risk from bond investors
to other parties may be insurance companies or hedge funds to protect
against the default risk. However, as depicted in the chart below, the
financial institutions may sell and resell the insurance contracts
among themselves creating the ‘entanglement of credit risk’. This also makes it difficult to identify who bears the ultimate risk.
This reselling of insurance contacts to another party has created a
near untraceable credit risk web among the market participants.

Source: The New York Times

The growth in CDS market in the last few years has
outstripped that of the US
equity and bond markets

The credit
derivatives market has grown at a remarkable pace as reflected from the
tremendous increase in total notional amount outstanding over the last few
years. The total notional amount of credit derivatives as of June 2007 increased
to US$42.6 trillion, an increase of 109% over the US$20.4 trillion reported in
June 2006. This has been driven by both the rise in single name CDS and the multi
name CDS instruments. The significant rise in the multi name CDS (traded
indices) has notably surpassed the growth in single name CDS. Single name CDS’ total notional amount
outstanding has increased from US$7.31 trillion in June 2005 to US$24.2
trillion in June 2007 while the multi name CDS has grown from US$2.9 trillion
in June 2005 to US$18.3 trillion in June 2007.